For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

In addition to prepping my yard for the summer, my spring rituals include reflecting on changes that have occurred over the past year. As always, some things have changed, while others remain the same. My children are a year older, but for some reason they still need help with their homework when I’m mulching.

More broadly, we’ve seen another year of progress in the stabilization of the U.S. economy (https://personal.vanguard.com/pdf/ISGVEMO.pdf) and another flurry of policy discussions in the media. This time, though, the Federal Reserve has to share the stabilization spotlight with policymakers on Capitol Hill. The optimist in me believes that the policy changes being discussed reflect and can help drive a sustained expansion in the United States, but the realist in me understands how difficult that may be.

Economists view monetary policy as a reflection of economic conditions. Just as I cut my grass only when it needs it, central bankers adjust monetary policy only when economic conditions warrant it. Against the backdrop of a strengthening U.S. economy, the Fed is gradually normalizing policy, which includes raising its policy rate and, likely sometime later this year, starting to reduce the size of its balance sheet.

Just as the Fed’s purchase of assets to expand its balance sheet was a real-world experiment in monetary policy, the implications of a gradual roll-off of assets held by the Fed are largely unknown. This is why, much like the process of increasing interest rates (“It’s takeoff, not liftoff”: https://vanguardblog.com/2015/09/11/its-takeoff-not-liftoff/), balance-sheet normalization will be slow and gradual. We believe that, in order to minimize market impact, this will include three important components:

Public communications about the plan will continue, with an announcement about the agreed-upon program coming in the late summer or early fall.

The framework will consist of two key points: the pace of roll-off and the targeted size of the balance sheet at the end of the program.

The Fed will initially use only one “tool” at a time and pause changes in the policy rate until the impact of balance sheet roll-off is better understood. Looking to the end of 2018, it is difficult to envision a scenario where the policy rate is 2% or greater.

If the announcement and implementation of the roll-off plan are handled in a clear, transparent, and gradual manner, there should be minimal market effect.

Change is a process, not an event

Changes are also afoot on the fiscal-policy front—changes that many people hope will push the United States back toward pre-recession rates of growth. That said, we at Vanguard believe that expecting big changes in 2017 may be overly optimistic.

Fiscal stimulus and structural changes, including infrastructure spending and tax reform, have the potential to shape our economic and financial market environment for years to come. These policies need to be vetted and implemented with care. Even if we were to see one or the other announced later this year, the economy would not realize their benefits until sometime in 2018. The most we can hope for this year would be increased confidence about the potential for policy change. While this confidence could very well push growth and inflation higher in the near term, recent softness in data and gridlock in Washington may begin chipping away at this positive sentiment.

The last 12 months have seen significant change in economic conditions, particularly in the United States. Growth is stabilizing, and inflation continues moving toward the Fed’s target of 2%. As with any economic data, rates of growth and inflation will ebb and flow, but we as investors should look past those toward bigger-picture trends.

Headwinds remain

Even if there are short-term boosts to growth or inflation this year or next, the realist in me remains concerned that the types of policies being proposed, while a step in the right direction, won’t be enough to counteract the structural headwinds we outlined in our Economic and Market Outlook (demographics, technology, and globalization).

Aside from the possibility of near-term cyclical boosts to growth and inflation, for the longer term, we would expect each to hover around 2% compared with pre-crisis average rates north of 3%. But rather than being seen as weak, such conditions should be viewed as fundamentally sound given the pressures of structural forces.

Seasons change, and so do policies, though ideally not as frequently. Investors would be well-served in the long term to focus more on their spring cleaning and fall leaf raking than in trying to construct a portfolio that fits an ever-evolving policy environment. While policy certainly can shape our economic and financial market environment, trying to predict with precision the timing, impacts, and duration of specific policies is as fruitful as when I look for help moving the 50 yards of mulch from my driveway.

Note: All investing is subject to risk, including the possible loss of the money you invest.

Joe Davis

Joe is Vanguard's global chief economist and head of Vanguard Investment Strategy Group. He's also a member of the senior portfolio management team in Vanguard Fixed Income Group. Joe's global research team is responsible for overseeing Vanguard's investment methodologies and asset allocation strategies for both institutional and individual investors. They also provide thought leadership on a broad range of investment topics, including the capital markets, the global economy, and portfolio construction. In 2004, Joe was selected as a faculty research fellow at the National Bureau of Economic Research for his contributions to the fields of economic history and U.S. business cycles. Before joining Vanguard, Joe spent time as an economist at Moody’s Analytics. Joe earned his M.A. and Ph.D. in economics at Duke University.

Comments

Robert C. | August 7, 2017 9:56 am

I see here a lot of normalcy bias. Most of us unless you happen to be close to or 100 years old have no adult recollection of the great depression some of us may have heard about it from parents or great grand parents or read about it. The closest most of us have come is the great recession and mortgage crises. What we saw for a short time was deflation for a couple of years not a decade as seen in the depression. During the great recession homes could be purchased for 20-40% less an brand new cars for $5000 off sticker price stocks were 30 to 40% lower. Since this deflation happened over a short term of 2-3 years most of us treated this as a fluke not a preview of the future. This time rather than just bad loans the problems are both structural, demographic and debt related. Massive immigration is holding down both unskilled and skilled wages. Massive student debt and of $1 Trillion and lack of purchasing .is postponing home and car purchases among younger people. Baby boomers are moving rapidly into retirement and with continue over the next 10 years at a rapid pace. Other than medical spending most spending drops in retirement, homes are down sized, and cars don’t get driven or replaced as often. Most retired boomers will be net sellers of stocks and homes over the next 10-20 years. Therefore a lack of younger buyers with enough purchasing power will cause a deflationary period of 10 years or more until prices fall to meet purchasing power of younger buyers

Donald G. | May 22, 2017 9:20 pm

To Mr Davis: Sir another very informative and “eye opening ” article.I think we need to take a step back and snap out of this daily tunnel vision we seem to be suffering from.My relationship with Vanguard is set up for LONG term wealth accumulation.I really do not listen to any what if programs.If you look at history over the long term that includes every calamity from World Wars,financial chaos of all types the market has ALWAYS rewarded the long term investor.There is a reason that Vanguard teaches buy the whole market-duh you pretty much know that you have protected yourself from major calamities.I may have it wrong but I use the market to make me money. I could care less about beating the market. I know that I can get wealthy over the long haul just accepting what the market makes for me.Every year or two I bring up my portfolio and based on FACTS of my program I sell high and I buy whatever has gone down.I am afraid I just do not lose any sleep over the day to day problems that hit the airwaves,papers and magazines.Mr. Bogle seems to think this buying low and selling high will make you money.We just passed our 4th TRILLION this past January of 2017 and I think that somebody is doing something right! I plan on helping my company get our 5th trillion is 2018! I love reading all of the articles in these blogs. They are always informative and give our brains a jolt every so often. Good Luck to all with your programs

Jeffrey D. | May 21, 2017 2:15 am

Here is a different take on GDP. The GDP components need to be looked at independently. One component, Millennials and college debt, are holding down GDP. Millennial’s excessive college debt’s (adverse) impact on the economy reduces GDP (perhaps by 1/4 to 1/2 point annually). Why: Excessive college debt delays family formation, home/apartment purchases, thus delaying the housing “trickle-down” effect that propels the economy (reminder: GDP is 70% consumer driven, of which housing is a large component). That is why it is important to quickly resolve college debt.
However, there is a way to mitigate college debt and it involves negotiating between the Trump administration and financial institutions owning college debt. Specifically, banks gain from a weakening of government regulations and they give back by writing down college debt (looking backwards for multiple years).
Solution: Hence, reduce college debt interest rates retroactively, freeing up funds for Millennials to immediately invest in the economy.
A second GDP observation is that spending by Baby Boomers likely slacks off from prior levels, hence another driver contributing towards “dragging” down GDP to 2% (or less).

Nicholas F. | May 26, 2017 3:33 pm

Housing accounts for about 17% of GDP: 5% in residential investment and 11-12 in housing services. Home owners’ imputed rent (an estimate of how much it would cost to rent owner-occupied units) is included in GDP but not the cost of a home purchase. Those delaying housing purchases are generally renting which is included in the housing component of GDP.

It is intuitive to believe that student loan interest payments suppress GDP as well as to believe that the education received adds value to GDP but I am unaware of any significant study of the issue.

Roy K. | May 21, 2017 12:44 am

Not all investors are the same, nor are retired investors all the same. My preference is to better understand the slice of retiree population for ages 75-plus. We are long-term investors who have 15 or more years ahead, and who are not first looking at 30 years or more of retirement.

Assumptions: we likely have an estate plan including all the necessary paperwork for end-of-life and other directives including powers of attorney for health, etc. The focus is on investing in varying risk categories.

Donald N. | May 20, 2017 5:39 pm

If expanding the balance sheet by the Fed was an inflationary boost, why won’t shrinking the balance sheet be deflationary to the same extent? Being sanguine about the admitted “experiment” seems more an expression of personal optimism rather than economic insight.

Alan P. | May 20, 2017 4:14 pm

I have no idea what roll off or balance sheets are, perhaps next time a simpler phrase could be used so us non financial people can better understand. I do understand about mowing grass when needed comparison is and also no help moving mulch. I have no confidence this administration can deliver on tax reform, infrastructure and other things that have been proposed. With that, I worry about global investment plans, the Brexit movement, energy cost with the ongoing Middle East crisis and also the continued deteriorating condition in Venezuela and Brazil. My Vanguard investment manager assures my portfolio is
set up to deal with these concerns over time. Keeping as possible is much appreciated. Thanks

Thanks for the article. Being a pretty typical working class professional, I don’t fully understand all the politics, but I certainly try to — I have the main understanding of what you are conveying. “Hey, don’t worry about it. We have responsible people at the heart of our central currency working on it.” And we could probably also add, “Invest in the good times, invest in the bad times, easy…” As a recovered active investor, Vanguard has given me a lot of peace. Thank you for that!

Francis T. N. | May 16, 2017 5:23 am

John C. K. | May 15, 2017 6:05 pm

Joe S. | May 15, 2017 3:47 pm

HI Joe, When the Fed starts to roll-off its balance sheet is the stuff that keeps us engaged, thinking and at times a bit anxious. This is what life is about. When you move the fifty yards of mulch from your driveway you’ll be able to sit back, have a cold drink and say, “good job Joe”. Life really is great. Best wishes, Joe S. Vanguard client

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.